Employee Excluded from Deferrals

[Guest Patkelley007]

A 401(k) plan mistakenly excluded an eligible employee from making deferrals. I believe I understand the Rev. Proc. 2006-27 correction to be a QNEC of 50% of the missed deferral (ADP for employee's group * employee's comp for PY), adjusted for earnings.

However, the employee excluded is over 50. Rev. Proc. 2006-27 does not seem to address correction as to the catch-up. Employee asserts he would have done catch-up, had he been allowed to make deferrals. What is the appropriate correction with respect to the catch-up?

Thanks in advance for any suggestions.

[WDIK]

First of all, it is my understanding that a participant does not "elect" catch-up contributions. Rather catch-up contributions come into play as a result of a failed test or exceeded limit.

Secondly, I don't see how the employee's assertion regarding catch-up contributions is relevant in this situation. As you point out, the correction method you are suggesting is based on the average amount actually deferred and does not factor in the excluded employee's "after-the-fact" election.

[masteff]

It depends on how the plan is administered as to whether it's a separate election or not. However, catch-up contributions are only permissible to the extent the employee will exceed the lesser of the plan's limit or the 402(g) limit on contributions (ie maxed out their normal pre-tax contributions). If the EE does not exceed the lesser of the two limits just noted, then any catch-up contributions are recharacterized as regular pre-tax contributions after year end.

So the question is... which way do you want the answer to be?

Answer 1 - yes, the EE should get some extra for catch-up

The offering by the plan of making catch-up contributions is a separate right or feature with respect to the correction, in which case I would look into using 50% of the average catch-up made to the plan. (I'm going off the top of my head on this, but it seems consistent and objective.) It would have to be done for anyone age 50 or over and not just this one person.

Answer 2 - no, the EE does not get anything extra

Catch-up is merely an extension of the limit on maximum pre-tax contributions. Catch-up merely means the EE is allowed to contribute more, it does not create an extra burden on the plan to provide additional correction. Code Section 414(v) says the individual's 402(g) limit is increased by the amount in 414(v)(B)(i). This increase applies outside of the plan (for example for employees who participate in more than one plan during the year and must combine their contributions for purposes 402(g)). When a plan provides a catch-up feature, they are merely agreeing to monitor and limit employees' overall pre-tax contributions to the higher limit and recordkeep them accordingly. Catch-up is not a separate type or form of pre-tax contributions, just a higher allowed amount. (I'd look closely at the plan's wording with respect to catch-up.)